Touted US Offshore Oil Drilling Expansion Hinges on High Prices

Energy producers are likely to need years more of high oil prices in order to develop any new reserves opened up by the lifting of offshore drilling restrictions.

With oil futures above $140 a barrel and U.S. retail gasoline prices above $4 a gallon, tapping restricted coastal waters for crude has become a central cause of Sen. John McCain's, R-Ariz., presidential campaign. Although the Democratic majority in Congress remains opposed to the idea, some in the industry see a chance at a compromise that would allow individual states to allow drilling in federal waters off their coasts.

That could give producers access to new territory in the Gulf of Mexico near Florida, or the Atlantic Ocean off Virginia, with drilling off the west coast a more remote possibility. Government forecasters see as much as 18 billion barrels of oil and 76 trillion cubic feet of natural gas, though in the vast majority of restricted areas the data is so old that the real potential is a mystery.

Oil and gas producers are, predictably, lobbying hard for the chance to find out what's there. They point to major discoveries off the coast of Louisiana, in parts of the Gulf of Mexico that were thought to be devoid of oil 15 years ago.

The Gulf is one of the only parts of the country where oil production is rising, with established fields such as Mars and Na Kika likely to be joined by major finds from recent years like Jack and Kaskida. Most of these reserves lie less than 300 miles from the restricted region of the Gulf near Florida. Some believe the Atlantic Ocean's seabed bears a resemblance to parts of offshore Brazil where billions of barrels of oil were discovered last year.

But the industry is also certain to need high prices to pay for finding and extracting oil and gas hidden in the newly accessible seabed. Few rigs and even fewer people are sitting idle, waiting for an oil rush in virgin territory. Producers will either need to pull equipment and personnel from other projects or pay through the nose. Either solution is likely to delay production of some of those 18 billion barrels; other newly opened areas could remain untouched for lack of rigs or money.

"There's certainly the potential for multibillion-barrel resources to be found," said Dalton Polasek, chief operating officer with Mariner Energy, a Houston-based energy company with assets concentrated in the Gulf of Mexico. "Perhaps the bigger question is, where are you going to get the rigs to test newly opened acreage?"

Rigs More Precious Than Oil

It would cost up to $600,000 a day to rent an offshore rig capable of drilling in the deeper waters of the Gulf of Mexico, though even a deep-pocketed producer would be unlikely to find one available before 2010. That price would almost certainly skyrocket if the U.S. opened up even a small portion of the 600 million acres it currently restricts. Shallow-water rigs are cheaper, but are also seeing dramatic markups, with many operators leaving U.S. waters for more lucrative contracts in the Middle East and India.

"It's not a situation where there is excess capacity with regard to rigs. The demand pull worldwide continues to be strong," said Bill Herbert, an oilfield services analyst with Simmons & Co. "Pricing clearly would have to go up in the Gulf of Mexico in order for those rigs to repatriate back to us."

Herbert estimates that shallow-water rig prices would rise from $150,000 a day today to at least $200,000 a day if the U.S. lifts drilling restrictions.

Even at $140 oil, service costs start to add up. A large new project offshore can easily cost over $1 billion, and as expenses have risen, companies have come to rely on higher and higher prices of oil to ensure that developments pay for themselves. Even in areas known to contain large amounts of oil and gas, not every promising rock formation ends up getting drilled.

"A single deepwater well can cost more than $100 million, so drilling decisions are made very carefully," Polasek said.

Drilling Into The Unknown

Producers will need to proceed carefully because, despite the 18-billion-barrel figure released by the government, no one knows what's really in the off-limits waters.

The U.S. Minerals Management Service, which oversees offshore energy development, came up with the estimate by extrapolating from nearby fields and exploration work performed before bans were implemented.

In other words, it's mostly guesswork. The Atlantic and Pacific coastal waters are almost entirely undeveloped, with even surface exploration work banned since the 1980s. The restrictions came as states worried about the environmental and economic impact of a spill from an offshore platform.

Huge quantities of natural gas and some oil were discovered in the 1970s and 1980s in shallow Gulf of Mexico waters off the Florida Panhandle, before the then-President George H. W. Bush put the eastern Gulf off limits. Florida's governor and legislature now support lifting the ban, as does the Virginia legislature.

Long Lead Time

Production out of the Atlantic would take 10 years or more. But energy companies estimate that wells could be drilled less than two years after Florida opens its waters. Gas would then be piped a short distance to existing infrastructure in Alabama.

"Your drill times and drill costs are ... probably a third of what they'd be out in deepwater," said William Van Wie, vice president of exploration at Devon Energy Corp., an Oklahoma City-based producer that is one of the largest leaseholders in the deepwater Gulf of Mexico.

A large shallow-water project might cost $200 million, compared with $3 billion for a big deepwater field, Van Wie said. California, the most promising region for new oil finds, is almost certain not to lift restrictions, he said.

The most promising projects have almost without exception seen massive cost overruns and lengthy delays. But companies have also bid record amounts this year for the privilege to develop new territory leased by the government.

"What (producers) do is prioritize geological prospects," Yergin said. "You can't prioritize if you don't have the data."